Appeal from the United States District Court for the Northern District of California Susan Illston, District Judge, Presiding D.C. No. 3:01-cv-00988-SI
The opinion of the court was delivered by: Tallman, Circuit Judge
Argued and Submitted July 13, 2010-San Francisco, California
Before: Ferdinand F. Fernandez and Richard C. Tallman, Circuit Judges, and Thomas F. Hogan, Senior United States District Judge.*fn1
Oracle Corporation is the second-largest producer of software in the world. In the third quarter of its 2001 fiscal year, Oracle missed its forecasted earnings per share by two cents. Its stock price dropped. A legion of analysts blamed the miss on a late-quarter reaction by several key customers to the unfolding U.S. economic downturn that would become commonly known as the burst of the dot-com bubble. Plaintiffs, several intra-quarter purchasers of Oracle common-stock, brought this securities litigation against Oracle and three of its officers alleging the miss was actually caused by an elaborate scheme to defraud the public about the quality of Oracle products and the revenue gained therefrom. Because Plaintiffs have not developed evidence sufficient to permit a reasonable jury to conclude that their losses were caused by the market's reaction to Defendants' alleged fraud, as opposed to Oracle's poor financial health generally, we affirm the district court's order granting summary judgment in favor of Oracle.
Plaintiffs allege that: (1) Defendants violated Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Securities Exchange Commission Rule 10b-5; (2) Oracle's Chief Executive Officer Larry Ellison, Chief Financial Officer Jeffrey Henley, and Executive Vice President Edward Sanderson are liable as control persons under Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a); and (3) Henley and Ellison are liable for contemporaneous trading under Section 20A of the Exchange Act, 15 U.S.C. § 78t-1(a). To support these allegations, Plaintiffs claim Defendants made false and misleading statements about a new software product, issued a false and misleading forecast for the third quarter of Oracle's 2001 fiscal year, made false and misleading intra-quarter statements, and fraudulently overstated earnings for the second quarter of the 2001 fiscal year. The following undisputed facts are relevant to those claims.
In May 2000, Oracle released integrated business software called Suite 11i, a suite of programs designed to work together to manage various company activities such as manufacturing, customer relations, sales, and accounting. Traditionally, enterprise resource planning ("ERP") applications performed functions such as accounting, human resources, and manufacturing. Customer relationship management applications ("CRM") performed functions such as managing call centers. Through the late 1990s, businesses that used enterprise applications software could not obtain ERP and CRM applications from the same vendor. Suite 11i was marketed as an innovative product that would combine the two types of applications.
The four quarters of Oracle's 2001 fiscal year were: from June 1 to August 31, 2000 ("1Q01"); from September 1 to November 30, 2000 ("2Q01"); from December 1, 2000, to February 28, 2001 ("3Q01"); and from March 1 to May 31, 2001 ("4Q01"). In 1Q01 and 2Q01, Oracle earned a combined $435 million in revenue from applications licenses. On December 14, 2000, Oracle announced 2Q01 earnings per share ("EPS") of 11 cents and 66% growth in sales of Suite 11i applications. The same day, Oracle issued public guidance for 3Q01 projecting EPS of 12 cents. This guidance was based upon an accounting process that had generated projections that Oracle had met or exceeded for seven consecutive quarters.
Historically, the majority of Oracle's sales were made in the final days of a quarter as customers waited for Oracle to significantly lower prices in an attempt to meet its quarterly projections. This trend was commonly referred to as "the hockey-stick effect" because plotting the quarterly sales on a graph resembled the shape of a hockey-stick-the sharp upswing at the end representing the bulk of quarterly sales.
Oracle generates numerous internal financial reports throughout any given quarter. Relevant to this litigation are intra-quarter reports projecting quarterly EPS-called internal forecasts-and intra-quarter reports aggregating the company's sales revenue at a given point in time-called flash reports. Internal forecasts are an aggregation of the revenue and growth data contained in flash reports. Whereas flash reports take a snapshot of revenue and growth at the time they are produced, internal forecasts are forward-looking and involve a degree of extrapolation based on the judgment and experience of corporate management.
From the beginning of 3Q01 on December 1, 2000, until February 5, 2001, every internal forecast that Oracle produced indicated that the company could fulfill its 3Q01 guidance. However, from February 5, 2001, until the end of the quarter, Oracle's internally projected EPS began to fluctuate. A February 5 internal forecast projected a potential EPS of 11 cents.
A February 12 internal forecast returned the quarter's potential EPS to 12 cents. A February 19 internal forecast again lowered the potential EPS to 11 cents. Then, a February 26 internal forecast-prepared two days prior to the end of the quarter-again predicted a potential EPS of 11 cents. While Oracle had exceeded late-quarter internal forecasts in quarters past, the recurring surge in late-quarter sales historically resulting from the hockey-stick effect did not materialize this time.
On March 1, 2001, Oracle preliminarily announced a 3Q01 EPS of 10 cents-a two penny miss. The announcement quoted Ellison as saying,
License growth was strong in the first two months of Q3, and our internal sales forecast looked good up until the last few days of the quarter. However, a substantial number of our customers decided to delay their IT spending based on the economic slowdown in the United States. Sales growth for Oracle products in Europe and Asia Pacific remained strong. The problem is the U.S. economy.
On March 2, 2001, Oracle's stock price dropped from $21.38 to $16.88.
Earlier in the quarter, Ellison and Henley had exercised millions of Oracle stock options. Henley sold one million Oracle shares for a total of $32 million on January 4, 2001. Ellison sold 2.09% of his Oracle holdings between January 22 and January 31, 2001. A substantial amount of the shares sold were acquired through options set to expire in August 2001. In total, Ellison sold a little over 29 million Oracle shares for approximately $895 million. Importantly, these sales predated the first internal forecast indicating a potential EPS lower than the quarterly guidance of 12 cents.
The district court originally dismissed Plaintiffs' revised second amended complaint for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6), finding that the allegations did not create a strong inference that intra-quarter statements made by Defendants were known to be false when made. See In re Oracle Corp. Sec. Litig., No. 01-CV-988, 2003 WL 23208956 (N.D. Cal. March 24, 2003). In November 2004 we reversed, holding that the operative complaint met the heightened pleading requirements of the Private Securities Litigation Reform Act ("PSLRA"). See Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226 (9th Cir. 2004). Copious discovery ensued.
On September 2, 2008, as a result of Defendants' failure to preserve all its potential evidence, the district court issued an order concluding that Plaintiffs were entitled to adverse inferences with regard to two categories of evidence: Ellison's email files and materials created in the process of writing the book Softwar. As a sanction, the court ruled that Plaintiffs would be entitled to an inference that the spoliated ...